Monday, October 7, 2013
Hussman Weekly Market Comment: When Economic Data Is Worse Than Useless
“Errors using inadequate data are much less than those using no data at all.” – Charles Babbage
“The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.” – Stephen Hawking
“If we have data, let’s look at data. If all we have are opinions, let’s go with mine.” – Jim Barksdale
I spend a large fraction of my waking hours working with numbers, particularly given that we follow a ruthless discipline of evidence-based investing. Generally speaking, I agree with Babbage that even inadequate (what I would call “noisy”) data leaves one less prone to error than using no data at all. One of our key activities around here, in fact, is noise-reduction. A sufficient amount of noisy data can still produce a clean or at least useful signal.
Still, numbers and data are only the workhorses of thought and insight, and an important part of data analysis to attend to any breakdown in relationships. During the 2000-2002 market plunge, and again in 2007-2009, investors who believed that one should always “follow the Fed” got their heads handed to them, as the market lost half of its value in both instances, despite persistent and aggressive Fed easing. Models that were too dependent on interest-rate trends fared particularly badly, as plunging interest rates did nothing to support stock prices. So while Babbage is correct to favor noisy data over none at all, Hawking is also correct, essentially warning us to constantly question what we believe to be true. From an analytical perspective, it’s helpful to pay attention to the “data-generating process” – looking carefully at the real-world mechanisms and interactions that
the data, in order to understand what is driving the numbers being observed.
Analysis of the data-generating process is one of the reasons that I’m convinced that quantitative easing will end in tears. Any economic policy achieves its effect basically by removing some constraint on the economy that was previously “binding” – holding the economy back in some way. If you look at QE, it should be clear that adding another trillion dollars of idle reserves will not relieve any constraint that is not already relieved by the trillions of idle reserves
in the banking system. QE basically has its effect on financial markets by forcing
to hold the zero-interest cash that the Fed has created, which makes them uncomfortable and leads to a game of “hot potato” as each cash holder seeks higher-yielding alternatives. That, in turn, drives up the prices and drives down the yields on those alternatives (primarily stocks) until someone is finally indifferent between holding zero-interest cash and chasing overvalued stocks. QE may not have any durable effects on the real economy beyond short-lived can kicks, but the impact of QE on financial distortion is cumulative. The harder the Fed pushes on the string, the larger the attached bubble becomes.